You’ve undoubtedly noticed over the past couple of years everyone is trying hard to invest in properties. The motivation behind this recent craze is the high-income homeowners earn in today’s market. Apparently, investors are looking for increasing revenue streams, and rents have become the best viable option at this point. But let’s not get ahead of ourselves. Let’s start by looking at how an individual can evaluate real estate.
Commonly known by its abbreviation SCA, this method is the most recognized in Houston, especially when dealing with the valuation process of residential properties. You don’t need to have a particular level of education for you to comprehend this approach. It’s nothing more than a comparison of similar houses around the area which have sold or rented in the past few months. So many investors will opt for the SCA if they want to predict any potential emerging trend in your neighborhood.
An SCA will always focus on particular property attributes before assigning a relative price value. In most cases, investors will use the price per square foot as the right metric to determine a home’s value. Let’s toss in a hypothetical situation where a 1500-square-foot house goes for one dollar per foot. For someone looking to invest in the same area, he or she will use that property to approximate what to expect.
The Capital Asset Pricing Model
When it comes to valuation, the CAMP is more comprehensive in that it introduces the probability concept of risk and the opportunity cost. The model will help you calculate the Return On Investment (ROI) from the rental income and compare this figure to other financial securities such as the Treasury bonds.
An individual may be trying to figure out whether to invest in a risk-free investment or rental property. If the expected return on the former is higher than the ROI of rental income, it beats logic to risk on rental property if risk is involved.
The income approach
The model will focus on the yields of the potential income relative to the initial investment. Investors tend to opt for this method when they are looking to spend in a commercial real estate.
You can only use this approach if you have a comprehensive understanding of the investment Capitalization Rate. Simply put, the Capitalization Rate is an estimated annual income calculated from a gross multiplier which gets divided by the current property value. So if you choose to buy an office building at 120,000 dollars and you expect a monthly rental income of 1,200 dollars, the annual Capitalization Rate will be 1,200 multiplied by 12 months and then divided by 120,000 dollars. That will give you two percent as your answer.
The cost approach
It is one model that values property based on its use. To come up with an estimate, you have to combine the value of the land and depreciated value of all the improvements. The appraisers will often put together the ‘best and highest’ use to define the cost approach in real property.
For instance, if you are the investor looking to invest in convert a three-acre land into condominiums, the property’s value gets based on its use.
A sober investor won’t just pick one approach without analyzing the components of all the models. Try to learn all these fundamental valuation concepts if you wish to stay ahead of the game.